Academy of Professional Accounting (APA) - 特许公认会计师（ACCA…accaspace.com/upload/ACCA_F3/PPT/F3_Chapter_11_Inventory.pdf · 2016-07-30 · “inventories should be measured

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ACCA F3

Financial Accounting (FA)

财务会计第十一讲

ACCA Lecturer: Carrie NI

Copyright © ACCAspace.comACCAspace 中国ACCA特许公认会计师教育平台 2

D3: Inventory

Definition

Costs of goods sold

Accounting for opening and closing inventories

Counting inventory

Valuing inventories


Definition

IAS 2 Inventories are assets:

held for in the ordinary course of business

in the process of production for such sale; or

in the form of materials or supplies to be consumed in the

production process or in the rendering of services.

Inventory can include raw materials, work in progress, finished

goods, goods purchased for resale.


Costs of Goods Sold

Accruals and costs of goods sold (COS)

The principle underpinning the SOPL is that of accruals. Therefore

the amount deducted from sales to give gross profit should be the cost of foods actually sold in the period.

$ $

Sales (45,000 units) 230,000

Less: cost of sales:

Opening inventory (10,000 units) 20,000

Add purchases (40,000 units) 95,000

(or cost of production for manufacturing company)

115,000

Less closing inventory (5,000 units) (12,000)

(103,000)

Gross profit 127,000


Costs of Goods Sold

Calculation of costs of goods sold

The purchases figure should therefore be adjusted for

inventory in stock at the start and end of the accounting

period.

Formula for costs of goods sold

$

Opening inventory X

Add: purchase (or production cost) X

Less: closing inventory value (X)

Cost of goods sold X


Costs of Goods Sold

Learning example

A business has sales of $100,000 during a year. Opening

inventory was $15,000 and purchases were $75,000. If the gross

profit was $15,000, what was closing inventory?

A. $5,000

B. $10,000

C. $25,000

D. $55,000


Costs of Goods Sold

Carriage

Carriage inwards

Cost paid by purchaser of having goods transported to his

business.

Added to cost of purchases. (above gross profit)

Carriage outwards

Cost to the seller, paid by the seller, of having goods transported

to customer.

This is a selling and distribution expense below gross profit.


Costs of Goods Sold

Learning example

Matt’s accountant has advised him that his cost of sales figure is

$23,560. He has counted the stock in hand at the year end and it

amounts to $4,320. He also knows that he had opening inventory

of $3,255 and paid $1,200 to transport goods to customers and

$670 delivery to suppliers for goods delivered to him. What is the

value of Matt’s purchase in the year?

A. $25,295

B. $22,755

C. $23,955

D. $24,625


Accounting for Inventory

Most businesses can’t keep track of inventory movements

throughout the year. Therefore they record purchases in the

nominal ledger, and at the year end make journal adjustments for

inventory. This approach is relevant to most small businesses

that can’t keep track of inventory movements. Large

organizations such as supermarkets will have inventory

management systems linked to accounting systems which are

constantly updated (when a purchase is scanned at the checkout).



Entries for purchases

Entries during the year

During the year, purchases are recorded by the following

entry (the inventory account is not touched at all):

Entries at year-end

The first thing to do is to transfer the purchases account

balance to the income statement:

DEBIT Purchases $ amount bought

CREDIT Cash or payables $ amount bought

DEBIT Profit or loss $ total purchases

CREDIT Purchases $ total purchases



Year end adjustments for inventories

The balance on the inventory account is still the opening inventory

balance. This must also be transferred to the statement of profit or loss:

The exact reverse entry is made for the closing inventory (which will be

next year’s opening inventory):

The closing inventory adjustment is the more important of the two, as it

trends to feature in more questions

DEBIT Profit or loss $ opening inventory

CREDIT Inventory $ opening inventory

DEBIT Inventory $ closing inventory

CREDIT Profit or loss $ closing inventory



Learning example

Florence has opening inventory of $2,100 and closing

inventory of $3,400. What is the impact of the year end

inventory adjustments on profits?

A. Profit increases by $1,300

B. Profit decreases by $1,300



Inventory overview

Inventory = Quantity X Valuation

Continuous

Inventory

Records

Inventory

Count

Lower of

Cost and NRV

$

Selling price X

Less: completion cost (X)

Less: selling costs (X)

X

All costs to get items

to current location in

current condition

FIFO Average cost


Counting Inventories

In order to ascertain the amount of closing inventory, a physical count is

normally performed. In order to record closing inventory, two pieces of

information are required:

1. The number of units of inventory;

2. The amount at which to value each of these units.

The number of units of inventory is established either from

A physical count

A continuous inventory count —— inventory management records:

some businesses keep detailed records of inventory coming in and

going out, so as not to have count everything on the last day of the

year; these records are not part of the double entry system


Valuing Inventories

The basic rule per IAS 2: Inventory is

“inventories should be measured at the lower of cost and net

realisable value.”

This is another example of prudence in presenting financial information.

A. If inventory is expected to be sold at a profit:

I. Value at cost;

II. Do not anticipate profit.

B. If inventory is expected to be sold at a loss:

I. Value at net realizable value;

II. Do provide for the future loss.


Valuing Inventories

Cost is the cost incurred in the normal course of business in bringing the

product to its present location and condition, including production

overheads and costs of conversion. The cost of an item of inventory

includes:

Cost of purchase

For example: purchase price, import duties

But not: sales tax, trade discounts

Cost of conversion

Relating to productions: direct labour, direct/variable overheads, an

allocation of fixed overheads (based on normal level of activity)

Other costs incurred in bringing the inventories to their inventories to

their present location and condition

For example: carriage inwards


Valuing Inventories

Learning example

According to IAS 2 Inventories, which of the following should not be

included in determining the cost of the inventories of an entity?

1. Labour costs

2. Transport costs to deliver goods to customers

3. Administrative overheads

4. Depreciation on factory machine

A. All four items

B. 1 only

C. 2 and 3 only

D. 2, 3, and 4 only


Valuing Inventories

If various batches of inventories have been purchased at

different times during the year and at different prices, it may

be impossible to determine precisely which items are still

held at the year end and therefore what the actual purchase

cost of the goods was. IAS 2 therefore allows an entity to

approximate the cost of its inventories. There are two

methods examinable:

First in, first out (FIFO)

Average cost


Valuing Inventories

First In, First Out (FIFO)

Under FIFO it is assumed that:

I. First goods purchased/produced will be the first to be sold

II. Remaining inventories are most recent purchase/production,

e.g., fruit and veg (grocers stack newer items under older so

that the older sell first)

Average Cost (AVCO)

E.g., oil/other liquids (deliveries are all mixed together in a vat

and become indistinguishable)


Valuing Inventories

There are two average costs available:

I. Simple average cost

The cost of all purchases/production during the year is

divided by the total number of units purchased.

II. Weighted average cost

The weighted average of the cost of similar items is

recalculated each time a new item is purchased/produced

during the period (IAS 2 requires the weighted average to be

used).


Valuing Inventories

Learning example

On 1 January 20x7 a company held 200 units of finished

goods valued at $10 each. During January the following

transactions took place.

Date Units purchased Cost per unit

10 January 300 $10.85

20 January 350 $11.50

25 January 250 $13.00


Valuing Inventories

Learning example cont’d

Sales during January were as follows:

Required

Determine the value of closing inventories and cost of sales

using:

A. FIFO

B. Weighted average cost

Date Units sold Cost per unit

14 January 280 $18.00

21 January 400 $18.00

28 January 80 $18.00


Valuing Inventories

Solution

A. Closing inventories (FIFO)

Opening Purchases

Sales Inventories 10 Jan 20 Jan 25 Jan

200 300 350 250

14 Jan (200) (80)

21 Jan (220) (180)

28 Jan (80)

Nil Nil 90 250

@ $11.50 @ $13.00

= $1035 + $3,250

$4,280


Valuing Inventories

Cost of sales (FIFO)

$

Opening inventories (200 x $10) 2,000

Purchases 10,530

12,530

Less: closing inventories (4,285)

8245


Valuing Inventories

B. Closing inventories and cost of sales (AVCO)

Units CostAverage

unit cost

Total

cost

Cost of

sales

$ $ $ $

1.1.x7 b/f 200 10.00 2,000

10.1.x7 Purchase 300 10.85 3,255

500 (W1) 10.51 5,255

14.1.x7 Sale (280) 10.51 (2,943) 2,943

220 2,312

20.1.x7 Purchase 350 11.50 4,025

570 (W2) 11.12 6,337

21.1.x7 Sale (400) 11.12 (4,448) 4,448

170 1,889

25.1.x7 Purchase 250 13.00 3,250

420 (W3) 12.24 5,139

28.1.x7 Sale (80) 12.24 (979) 979

340 4,160 8,370


Valuing Inventories

B. Closing inventories and cost of sales (AVCO)

(W1) $5,255 / 500 = $10.51

(W2) $6,337 / 570 = $11.12

(W3) $5,139 / 420 = $12.24


Valuing Inventories

Valuation effects on profit

Different valuation methods produce different inventory

values and so different profits. Using the FIFO, and average

cost examples above, this can be illustrated in a statement

of profit or loss.

FIFO Weighted average

$ $ $ $

Sales (760 x $18) 13,680 13,680

Cost of sales:

Opening inventories 2,000 2,000

Purchases 10,530 10,530

Closing inventories 4,285 4,169

(8,245) (8,370)

Gross profit 5,435 5,310


Valuing Inventories

The only figure that varies is the closing inventories, the

result being quite different profit figures. This re-

emphasizes the significance of inventory valuation in the

preparation of financial statements effects in times of

changing prices

In the above example, the purchase price of inventories

was rising during the period. Notice that when prices are

rising:

FIFO will tend to give higher inventory values and

higher profits.


Valuing Inventories

Valuation effects on profit


Valuing Inventories

Advantages and disadvantages

FIFO: more “realistic” value on statement of financial

position.

Average cost: can be complex as weighted average is

required by IAS 2.


Valuing Inventories

Net realisable value (NRV)

The net realisable value of an item is essentially its net

selling proceeds after all costs have been deducted. It is

calculated as:

$

Estimated selling price X

Less estimated costs of completion (X)

Less: estimated selling and distribution costs (X)

X


Valuing Inventories


Learning example

Jessie is trying to value her inventory. She has the following

information available:

Required

What is the net realisable value of Jessie’s inventory?

$

Selling price 35

Costs incurred to date 20

Cost of work to complete item 12

Selling costs per item 1


Valuing Inventories


The IAS 2 rule “lower of cost and net realizable value” should be

applied as far as possible on an item by item (or line by line)

basis.

The amount of any write-down of inventories to NRV and all

losses of inventories are recognized as an expense in the

periods the write-down or loss occurs

The amount of any reversal of any write-down of inventories,

arising from an increase in NRV, is recognised as a reduction

in the amount of inventories recognised as an expense in the

period in which the reversal occurs


Valuing Inventories

Learning example

Orinoco provides the following information about goods in

hand at the year end:

Before they are sold, the tennis rackets all need stringing at

the cost of $2 each. What is the value of closing inventory in

the statement of financial position?

A. $10,800 B. $10,000 C. $9,800 D. $9,350

Footballs Golf clubs Tennis rackets

Cost $5 $15 $10

Expected selling price $8 $14 $11

Units held 500 200 450


Valuing Inventories

Learning example

Which of the following statements about the valuation of inventory

is correct, according to IAS 2 Inventories?

A. Inventory items are normally to be valued at the higher of cost and

net realisable value

B. The cost of goods manufactured by an enterprise will include

materials and labour only. Overhead costs cannot be included

C. LIFO is an accepted valuation method for inventory. FIFO is not an

accepted valuation method for inventory

D. Selling price less estimated profit margin may be used to arrive at

cost if this gives a reasonable approximation to actual cost


Summary

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Professional Accounting Education

Documents

Academy of Professional Accounting (APA) - 特许公认会计师（ACCA…accaspace.com/upload/ACCA_F3/PPT/F3_Chapter_11_Inventory.pdf · 2016-07-30 · “inventories should be measured